SECTION A – CASE QUESTIONS (Total: 50 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.

CASE

Jerry and Lily are the founders, directors and shareholders of Quality One Limited ("Q1"),
which is a Hong Kong incorporated private limited company. Jerry and Lily are a married
couple (both aged 55) and both are Hong Kong residents, holders of the Hong Kong identity
card. Jerry and Lily have spent all of their time running the business of Q1 after they
graduated from university. They do not own any other business and have no investment.

Q1 has been engaged in the provision of product testing services for over 20 years. Details
of the operation are set out below:

 Q1 has an office cum service centre located in the Hong Kong Science Park.
It employs a team of 10 engineers and 5 administrative staff.
 The engineers are responsible for the provision of the core technical services to Hong
Kong customers, whilst the administrative staff are responsible for office administrative
activities, IT, HR and finance and accounting functions.
 The testing services include testing the products and reporting to the customers
whether their products meet international quality standards.

The following is the income statement of Q1 for the year ended 31 December 2020:

Engineering Administrative Total

Department Department
HK$ HK$ HK$
Revenue note 1 24,000,000 - 24,000,000

Expenses:

Salary 6,900,000 2,400,000 9,300,000

Office rental 600,000 600,000 1,200,000
Office expense 200,000 300,000 500,000
Royalty fee note 2 1,000,000 - 1,000,000

Total expenses (8,700,000) (3,300,000) (12,000,000)

Profit/ (Loss) before tax 15,300,000 (3,300,000) 12,000,000

Note 1
The product testing services were all performed by the engineers in
Hong Kong.

Module 14 (June 2022 Session) Page 1 of 9

Note 2
Royalty fee is paid to an unrelated non-resident recipient K Limited, which is
an international standard setting organization, for the right to replicate
the tests conducted when providing the product testing services. Based on
the licensing contract, the recipient is a Cayman Islands company having
a business address in Country X that has entered into a double tax agreement with
Hong Kong. The recipient is responsible for the tax attributable to the royalty
income.

In a regular management meeting taken place in early 2020 in Hong Kong, Jerry and Lily
were considering the following business restructuring initiatives to be carried out in 2021:

Business sale – engineering department

Jerry, who leads the engineering department, would like to change Q1's business model by
selling the engineering department that delivers the product testing services at market value
to a BVI company Quality Two Limited ("Q2"). Jerry will be the sole shareholder and director
of Q2 based in Hong Kong responsible for daily operations, work coordination and key
business decision making.

After the business sale (including the transfer of business assets/ liabilities, novation or
assignment of customer contracts, employees' employment, etc.), all engineers will be
encouraged to conduct the product testing services entirely at the customer's premises in
Hong Kong. Other ancillary business activities like supplies of testing material, team
meeting and training will be completed by online suppliers through online meeting.
All engineers will be either working from home or conducting field work at the customer's
premises.

Q2 will not obtain any registration under the Companies Ordinance and Business Registration
Ordinance. On the other hand, Q2 will maintain a bank account with DBB bank in Singapore,
for receipt of customer service revenue and disbursement of operating expense. The bank
account will be operated by Jerry in Hong Kong.

Business relocation – administrative department

Lily, who leads the administrative department, would like to move her department to a lower
cost location. The location in mind is Foshan (one of the cities in the Greater Bay Area).

Below is the basic research conducted by Lily on the comparison of the administrative
expenses (for the year ended 31 December 2020) between Hong Kong and Foshan:

Hong Kong Foshan Variance

(Before relocation) (After relocation)
HK$ HK$ HK$
Annual salary costs 2,400,000 1,800,000 (600,000)
Annual office rental 600,000 300,000 (300,000)
Annual office expense 300,000 200,000 (100,000)
Total 3,300,000 2,300,000 (1,000,000)

Module 14 (June 2022 Session) Page 2 of 9

The business activities of the administrative department are low-risk, not complex and routine
in nature and they will be conducted by a newly established mainland entity jointly owned by
Jerry and Lily.

Question 1 (10 marks – approximately 18 minutes)

With respect to the payment of royalty fee by Q1 to the non-resident recipient K

Limited:

(a) Outline the tax withholding and related reporting obligations of Q1 under
the Inland Revenue Ordinance ("IRO") as payer of the royalty fee.
(5 marks)

(b) Under the double tax agreement between Hong Kong and Country X, royalty
paid to a tax resident in Country X can enjoy a reduced withholding tax rate of
3%.

With reference to the OECD model tax convention, describe the typical
procedures Q1 should undertake in order to determine whether K Limited is
able to enjoy the reduced withholding tax rate. State the information/
document(s) Q1 should provide to K Limited in order to assist the latter's tax
filing obligation and obtaining tax relief in its tax jurisdiction.
(5 marks)

Question 2 (10 marks – approximately 18 minutes)

(a) If Jerry's business sale initiative is executed, analyse the taxation of the
business disposal gain earned by Q1 under profits tax.
(5 marks)

(b) Analyse whether Q2 is carrying on a business in Hong Kong, and evaluate

whether its profits are subject to profits tax.
(5 marks)

Question 3 (22 marks – approximately 40 minutes)

After the management meeting on the proposed business restructuring initiatives,

it was decided that Jerry's business sale initiative will not be carried out (i.e. operation of the
engineering department will remain in Hong Kong under the name of Q1), whilst Lily's
business relocation initiative will go ahead (i.e. the administrative department of Q1 will be
moved to Foshan). The management would like to understand the tax impact of the
relocation plan with reference to the financial information for the year ended 31 December
2020.

Module 14 (June 2022 Session) Page 3 of 9

(a) Evaluate which one of the following transfer pricing methodologies
(no calculation is required) is more appropriate if the administrative
department is relocated to Foshan, and its financial position should be
sustainable.

- Cost plus method

- Resale price method
(4 marks)

(b)(i) Calculate the profits tax liability of Q1 for the year of assessment 2020/21
assuming all expenses are deductible.

Then calculate the profits tax liability of Q1 and the Mainland China corporate
income tax liability of the mainland entity as if the business relocation initiative
has been carried out, using the financial information provided in the case and
the tax rate of 16.5% and 25% respectively. Assume the mainland entity will
be remunerated on cost plus 10% basis for the administrative services it
provides to Q1. Ignore the 2-tier profits tax regime in Hong Kong for the above
calculations.

Further calculate the after-tax earnings available to the shareholders Jerry and
Lily, taking the 5% dividend withholding tax rate in mainland China. Analyse
whether there is a benefit overall, taking into account the amounts of tax
liability and cost saving.

For clear presentation, you are suggested to:

 Calculate the post-relocation profit or loss for Q1 and the mainland entity
in separate columns in tabular format.
 Ascertain the post-relocation after-tax profit of Q1 and the mainland entity
by applying the appropriate tax rates.
 Quantify the net benefit brought by the relocation, if any to the
shareholders.
(10 marks)

(b)(ii) Explain (no calculation is required) how the amount of net benefit from
restructuring will change when the service fee charged to Q1 by the mainland
entity is increased.
(4 marks)

(c) Describe a possible action Q1/ mainland entity can take in advance in order to
avoid the undesirable situation that the Hong Kong and Mainland tax
authorities disagree with the transfer price between Q1 and the mainland entity.
Evaluate whether this possible action is appropriate in the circumstances.
(4 marks)

Module 14 (June 2022 Session) Page 4 of 9

Question 4 (8 marks – approximately 14 minutes)

Jerry was elected as the Legislative Council member of Country Y. Since the election Jerry
has to spend more time on council meetings and provision of business consultancy services
to overseas contractors bidding for government civil contracts. Knowing this you would like
to propose to Jerry outsourcing his Tax Return – Individuals filing with the Inland Revenue
Department to your accounting firm.

A junior member of your firm has drafted a tax compliance service proposal to Jerry, below is
an extract of the service proposal:

"…..the following tax compliance services are proposed on the grounds that you are not
holding any prominent public functions in Hong Kong or overseas.

We will prepare your Tax Return – Individuals and supporting tax computation for the year of
assessment 2021/22. On condition that you have paid the fee of HK$xxx to us, we will claim
your business consultancy fee income of HK$xxx as offshore, not subject to salaries tax, and
assure you that (1) the claim will be accepted by the Inland Revenue Department ("IRD") and
(2) the claim will not be challenged by the IRD within 6 years.

We will collect and, if necessary, produce all information/ estimates/ documents that support
the above claim. Please rest assured that we will think out of the box and be creative in
preparing the tax return and tax computation, and we are responsible for the content
therein….."

Required:

In respect of client acceptance procedures, highlight the issues to the partner that the
firm should pay attention to in terms of the new role of Jerry in Country Y and the
requirements under the Anti-Money Laundering and Counter-Terrorist Financing
(Financial Institutions) (Amendment) Ordinance 2018.

As the manager-in-charge of this pursuit, suggest 3 ethical issues to be discussed with

the partner in respect of the draft service proposal.
(8 marks)

* * * * * * * *

Module 14 (June 2022 Session) Page 5 of 9

End of Section A
SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.

Question 5 (15 marks – approximately 27 minutes)

Mr Johnson was born in England and is the Vice President of an investment bank in England.
Mr Lo was born in Hong Kong. He is employed by M&L Company Limited as Senior Finance
Manager in Hong Kong. He is also the sole proprietor of a boutique in Hong Kong.
Mr Lo has been the sole owner of a property in Hong Kong, Amber Residence, since 2017
and has been residing there.

On 30 June 2019, Mr Johnson was legally married to Mr Lo in England. On 1 July 2019,

it was Mr Johnson's first-time travel to Hong Kong. During his stay in Hong Kong,
Mr Johnson purchased two properties, Bella Building and Charlotte Court.

On 30 September 2019, Mr Johnson returned to England and he did not travel to Hong Kong
until 1 April 2021.

Other information:

(i) Mr Lo received the net income of HK$735,000 from M&L Company Limited for
the period from 1 April 2019 to 31 March 2020 after deducting his mandatory
contributions made to a mandatory provident fund scheme in the amount of HK$18,000.

(ii) Mr Lo's boutique had an adjusted loss of HK$80,000 (after deducting approved
charitable donation of HK$3,000).

(iii) Mr Lo's mother has been eligible for an allowance under the Government's Disability
Allowance Scheme since January 2019. On 1 October 2019, Mr Lo moved out of
Amber Residence and lived with his mother to take care of her.

(iv) Bella Building and Charlotte Court were both let out commencing from 1 September
2019 for a monthly rental income of HK$16,000 and HK$20,000 respectively.

(v) Mortgage loans were obtained to finance the purchase of Amber Residence,
Bella Building and Charlotte Court and the monthly mortgage interests paid were as
follows:

The monthly mortgage interest

Property HK$
Amber Residence 7,000
Bella Building 17,000
Charlotte Court 14,000

Module 14 (June 2022 Session) Page 6 of 9

Required:

(a) With reference to the relevant provisions of the IRO and the legal principles,
analyse whether Mr Johnson and Mr Lo could elect for personal assessment for
the year of assessment 2019/20.
(5 marks)

(b) Compute the total tax liabilities of Mr Johnson and Mr Lo for the year of
assessment 2019/20 assuming that they elected for personal assessment jointly
and claimed deductions and allowances entitled to them. No apportionment of
tax payable between Mr Johnson and Mr Lo is needed.
(10 marks)

Question 6 (10 marks – approximately 18 minutes)

JC Trading Inc is a leading grocery and food distributor incorporated in the United States.
It expanded its business to Hong Kong and set up a branch in Hong Kong. At first,
JC Trading Inc employed two employees in Hong Kong to conduct market research on the
customers' preferences and purchase patterns for grocery and food. They also set up
roadshows to build brand awareness in Hong Kong. Two years later, JC Trading Inc sent
its employee Ms Morrison to negotiate all trading terms and conclude contracts with
customers in Hong Kong. All trading contracts were signed under JC Trading Inc's name.

Required:

JC Trading Inc has engaged you as its tax advisor. Prepare a memo to JC Trading Inc
to advise, with reference to the relevant provisions of the IRO, the profits tax
implications of JC Trading Inc in Hong Kong.

Note: A maximum of 2 marks for communication skill and 2 marks for analytical skill will be
awarded.
(10 marks)

Question 7 (13 marks – approximately 23 minutes)

Mr Wong was employed by KT & Co. Solicitors & Notaries ("KT & Co") as Solicitor and he
enjoyed the following fringe benefits for the period from 1 April 2018 to 31 March 2019:

(i) Under his employment contract, Mr Wong was entitled to a housing benefit that
a monthly rent capped at HK$20,000 would be refunded to him by KT & Co. Mr Wong
was required to submit to KT & Co an application form together with copies of
the tenancy agreement and rental receipts on or before 31 March of each relevant year
of assessment. He rented a flat in Lai Chi Kok at a monthly rent of HK$22,000 for
the period from 1 April 2018 to 31 March 2019. On 1 July 2019, Mr Wong only
submitted an application form to KT & Co.

Module 14 (June 2022 Session) Page 7 of 9

(ii) KT & Co and Good Health Clinic entered into an agreement under which an employee
of KT & Co could visit Good Health Clinic by presenting a medical card and the medical
bill would be settled by KT & Co at the end of every month. The amount of medical
expenses paid by KT & Co in respect of Mr Wong was HK$6,800.

(iii) To promote a healthy work-life balance, an employee of KT & Co would be reimbursed

for the membership fee for joining any fitness centers in Hong Kong. Mr Wong
purchased an annual pass in Strong Fitness at HK$10,000 and was reimbursed the
same amount by KT & Co.

(iv) Mr Wong was required to handle KT & Co's clients in Macau. KT & Co paid Mr Wong
an allowance of HK$150 for each day Mr Wong worked in Macau to cover his
travelling expenses in Macau. The total amount of allowance received by Mr Wong
was HK$4,500.

(v) Mr Wong was required to work overtime during peak season. KT & Co reimbursed
Mr Wong for the taxi fare in the total amount of HK$2,000 for those days he left office
later than 11 pm.

Required:

Analyse, with reference to the relevant provisions of the IRO and the legal principles,
the salaries tax implications of each of the fringe benefits (i) to (v) above.
(13 marks)

Question 8 (12 marks – approximately 22 minutes)

K&K Limited is a company carrying on business of property development and letting in

Hong Kong. It closes its accounts on 31 December annually. K&K Limited was engaged
in a redevelopment project in District A.

On 1 June 2015, it acquired a vacant site in District A ("the Site") at a consideration of

HK$210,000,000 with an aim to create residential flats for sale.

On 1 January 2017, the construction work commenced and the cost of construction was
HK$250,000 per month.

On 31 December 2017, K&K Limited announced that the Site would be developed into two
buildings with 150 serviced apartments and the market value of the Site was HK$400,000,000
on that date.

On 1 July 2018, construction of the two buildings in District A were completed and all serviced
apartments were then leased out for a total rental income of HK$4,000,000 per month.
The expenses for operating the serviced apartments were HK$500,000 per month.

On 1 September 2018, K&K Limited sold the two buildings in District A to its subsidiary at
HK$800,000,000.

Module 14 (June 2022 Session) Page 8 of 9

Required:

Ignore the commercial building allowances in answering 8(a) and (b) below.

(a) Analyse, with reference to the relevant provisions of the IRO and the legal
principles, the profits tax implications on K&K Limited in respect of the
redevelopment project in District A.
(8 marks)

(b) Compute the amount of assessable profits of K&K Limited in respect of the
redevelopment project in District A for the years of assessment 2017/18 and
2018/19.
(4 marks)

* * * END OF EXAMINATION PAPER * * *

Module 14 (June 2022 Session) Page 9 of 9